Edited version of private advice

Authorisation Number: 1051978536505

Date of advice: 16 May 2022

Ruling

Subject: Rental property expenses

Question 1

Can you claim your share of the costs associated with the work carried out on your rental property as a repair?

Answer

No.

Question 2

Is the cost associated with the removal of external decking included in a capital works deduction?

Answer

No.

Question 3

Are costs associated with clearing, levelling, filling, draining or otherwise preparing the construction site prior to excavation works included in a capital works deduction?

Answer

No.

Question 4

Apart from works referred to in Question 2 and Question 3, are costs associated with the work carried out on the rental property included in a capital works deduction?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2021

The scheme commences on:

1 July 2020

Relevant facts and circumstances

You signed a contract to purchase several units.

You have a share in these properties.

You, along with the other owners received a building inspection report which noted cracking stating that: Large settlement cracking on corner of one of the units appears to be a structural defect, recommend having an engineer to assess if this a structural problem which requires underpinning.

The report also identified leaking pipes under bathroom in one of the units had resulted in water damage along with timber decks to some of the other units and are made out of untreated hardwood timber and are very weather and quite weak. Advise rebuilding.

Weather damaged handrails will need repair or replacing to restore integrity and appearance and safety

Cracks in concrete paths/steps need repair

These cracks were classed as settlement movement with no mention of landslip which ultimately cause the major subsidence that was later discovered.

The property settled several months later.

You along with the other owners got an engineer's report in the following months as per the recommendation in the building inspection.

The engineer's report stated:

Step cracking was observed on the Northern side of the building indicating settlement had occurred at the North West corner. This is indicative of settlement of the structure occurring at this corner. The remediation treatment recommended and undertaken was to lift and underpin the footing using a series of 8x 400mm diameter x 1800 deep bored piers. This work was subsequently undertaken to correct and stabilise the observed displacement by providing a firm non-reactive base to reduce the risk of further subsidence.

No assessment of the interaction of the site's landslip category with the possibility of future movement has been undertaken and no guarantees are provided that further movement will not take place due to the building being located within a medium landslip category. Further investigation by a geotechnical engineer will be required to quantify the risk in this regard.

You received an email from the tenant living in a unit (through the real estate agent) stating that they were worried about the house block walls cracking.

You received another email from the agent stating that the tenant was concerned about their safety.

You advised the tenant to move out for her safety.

You discovered that the settlement movement at the unit was actually a subsidence issues which had caused several issues which needed to be fixed such as releveling the house, restoring and underpinning the foundations, replacing sliding doors/windows, repairing parts of the interior including the kitchen and flooring close to the sliding door which had water damage because of leaks from door losing its seal, and replacing the deck which was removed for the excavator to drill piers.

Shortly thereafter, work began on fixing these issues.

First the external decking was removed in order for the excavator to get close to the unit.

Once the decking was removed excavator drilled piers ready for concreting to underpin the foundations.

Work began on installing external drainage to divert water away from the house to help prevent any more subsidence and internal rot.

Work began on replacing the balcony.

Later that same year, underpinning and repairs were completed on the exterior damage caused by the subsidence. Along with the installation of a concrete pad to help with stabilizing the foundation

Once the foundation was secure you proceeded to repair internal water damage caused by the subsidence. The subsidence had caused the windows seals on the sliding doors to crack. This allowed water to leak in from the outside causing wood rot which need to be repaired

The subsidence caused a similar issue with the kitchen windows. The subsidence caused the seals on the kitchen windows to crack. This allowed water to enter from the outside causing the flooring in the kitchen and the kitchen itself to have water damage.

Work on the external drainage was completed.

In the same month, work on the balcony was completed.

In the following months, work was completed on the internal damage.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Reasons for decision

Initial repairs

Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides for a deduction for expenses incurred for repairs to premises that are held or used solely for income producing purposes. However, a deduction for capital expenditure is not allowed under this section (subsection 25-10(3) of the ITAA 1997).

Taxation Ruling TR 97/23 explains the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10 of the ITAA 1997.

Paragraph 15 of this ruling explains that a repair involves restoration of the efficiency of function of the property being repaired without changing its character and may include restoration to its former appearance, form, state, or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. A repair is work done to make good damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes (whether expected or unexpected) over a period of time.

'Initial repairs' arise where a taxpayer makes good defects to property which existed at the time the property was acquired. Expenditure incurred for initial repairs represents the cost of improving the item from the condition it was in at the time of acquiring it rather than repairing ordinary wear and tear occurring while the item was owned and used by the taxpayer for income producing purposes.

If the defect or damage to or deterioration of the property existed at the time of acquisition of the property, and if it did not arise from the income producing activities of the person who incurs the expenditure, expenditure in remedying the situation is capital expenditure.

You and the other owners purchased the units.

You had a building inspection carried out on the units several months earlier.

This inspection identified a number of defects and recommended an engineer's report be carried out on the property.

The engineer's report was done after the properties had been purchased.

The engineer's report identified landslip and subsidence as the cause of the problems.

This report was not obtained until after the purchase of the property but was recommended prior to settlement to obtain one.

The defects in the property were present when you purchased the property, they did not arise out of normal wear and tear.

Remedying this is an initial repair and the expenditure incurred is capital in nature. Therefore, no deduction is allowed under section 25-10 of the ITAA 1997 for the cost of the work carried out on the unit.

Capital expenditure

Division 43 of the ITAA 1997 provides a deduction for expenditure on capital works.

Capital works covered by section 43-20 of the ITAA 1997, include a building, or an extension, alteration or improvement to a building begun in Australia after 21 August 1979.

Subsection 43-70(1) of the ITAA 1997 states that construction expenditure is capital expenditure incurred in respect of the construction of capital works. Subsection 43-70(2) of the ITAA 1997 lists a number of expenditures that are excluded from the definition of construction expenditure.

(2) Construction expenditure does not include:

(a) expenditure on acquiring land; or

(b) expenditure on demolishing existing structures; or

(c) expenditure on clearing, levelling, filling, draining or otherwise preparing the construction site prior to carrying out excavation works; or

(d) expenditure on landscaping; or

(e) expenditure on * plant; or

(f) expenditure on property for which a deduction is allowable, or would be allowable if the property were for use for the * purpose of producing assessable income

A deduction is allowable under section 43-10 of the ITAA 1997 for capital expenditure incurred on the improvement to certain income producing buildings. The deduction is either 2.5% or 4% of the construction expenditure, depending on when construction started and the purpose for which the capital works are used.

You are able to claim part of the expenses of your rental property as part of the work carried out is an improvement to the building, it therefore qualifies as construction expenditure for the purposes of claiming a capital works deduction.

You cannot claim the expenses associated with the demolishing of the decking or balcony along with any other existing structures at the property.

You are not able to claim the expenses associated with clearing, levelling, filling, draining or otherwise preparing the construction site prior to carrying out excavation. Note, this does not include drilling of piers or installing drainage, as these are not costs of preparing the site for excavation.